Financial spread betting explained

Use this guide as an introduction to financial spread betting and aims to answer the following questions.

What is financial spread betting?

What is a stop loss?

What are the advantages of financial spread betting?

What can I trade?

At Let’s Compare we view financial spread betting as something different to finanacial spread trading. Trading involves strategy and money management. There are links to spread trading strategies in this guide.

Spread betting used to be the preserve of city experts. Luckily, we now live in a global information nation… retail investors are catching on. Spread betting as an investment strategy is surprisingly flexible. Making spread betting on financial markets a valuable addition to anyone’s investment strategy.

What is financial spread betting?

Investors can bet cheaply on the rise and fall of an asset without owning it’. You can spread bet stock indices like the Dow Jones or FTSE. So far, this all sounds great. You must remember spread betting is a derivative product. In other words, you do not really own the underlying asset (share, commodity etc) – just something that follows what it does. The spread bet companies quote a buying and selling price of a particular asset or index, which is called the spread. Spreads differ form company to company and from bet to bet.

Unlike normal share investing spread bet companies do not usually charge commission on trades, stamp duty or capital gains tax (although losses can not be offset for capital gains tax). Spread betting is different to fixed odds betting and investing directly in shares (or savings products) because you can get exposure to large markets, individual shares with a high share price, or a commodity you can not buy directly with a small amount of money. This is called betting on margin. Spread betting companies offer different margins. If you have a 10% margin you only have to hand over a tenth of what you are really gambling with. You normally have to apply for a credit account, which will allow you to bet money that you don’t actually have in your spread betting account. Obviously, you need to ensure you can cover all your loses.

This small deposit amount means you can make large profits from a small stake. Potential loses can also be magnified. Click here for an example. Spread betting is high risk. Unlike more traditional gambling where you only lose the money you stake, profits and losses are potentially unlimited…..this is where the trusty stop loss steps in. You can tell your spread bet provider to ‘close out’ your trade if it moves too far in the wrong direction.

If you anticipate the price of the asset is going to increase you buy the spread betting companies quoted spread….this is called ‘going long’. If you believe the price will fall and you sell the quoted spread this is called ‘going short’.

Going long; you think the price of Vodaphone will rise. The spread is quoted at 130p – 131p. The actual price in the underlying market is 130.5p. You buy and stake £5 per point – you expect the price to increase. The price does in fact increase to 135.5; 5 pence or 5 points. Your spread bet wins 5 times your stake…… 5 x £5 = £25. If you decide to close out your trade your balance will increase by £25. Going Short; You think the price of Vodaphone will fall. You decide to sell. You stake £5 per point. The price falls by 5p. You win…. 5 x £5 = £25. Back.

If the price moves against you (in the opposite direction to where you thought it would), you lose your stake per point if magnified in the same manner. This makes spread betting risky. Using a stop loss will limit your risk.

The art of spread betting – of any asset – is minimising your potential losses and maximising the potential gains…… how do you do this? By using a stop loss, that’s how!

So what is stop loss?

This is when you limit your risk by determining in advance how much money you are prepared to lose. You use a stop loss to limit losses by closing the trade at a given price, although if the price shoots down before the stop loss order can be executed, you can still lose money. To ensure your spread bet is closed at the price you want you can use a guaranteed stop loss for a fee.

If you decide you want to limit your potential loss to £25. You have staked £5 per point. Vodaphone shares cost 130p. They start to fall. If you set your stop loss to 125p your trade is closed when the market price reaches 125p and you stop losses at £25.

Advantages of Spread Betting

Tax advantages. The tax advantages of spread betting vary depending on the country operating the spread betting account, for example, in the UK stamp duty is normally payable when purchasing stocks and shares. There is no stamp duty to pay when spread betting in the UK.
Profits from selling assets are normally subject to tax. In the UK profits from spread betting are not currently subject to capital gains tax.

Spread betting is low cost. It is very unusual to have to pay any fee or commission to the spread betting company.

Spread betting is good for trading. Spread bets can be ‘sold short’, producing a profit if the market falls, or ‘bought long’ producing a profit if the market rises.

Spread betting companies allow traders to trade on margin. A relatively small amount of money is required on account to place spread bets. This produces a multiplier effect for profits, and loses.

Spread betting provides access to lots of markets from the exotic, such as Asian markets, to commodities like metal prices, bond prices and more.
Flexibility with how to trade markets. Spread betting companies offer spread bets on cash markets (daily prices), and the derivative markets (for contracts expiring in the future).
Spread betting companies allows account holders to control risk and limit the multiplier effect on loses using a ‘Stop Loss’.

A safe environment to practice. Companies provide demo accounts with fake money to practice and some will allow small spread bet size.

Disadvantages of spread betting

Caution is required. Large swings and volatility can cause loses to mount quickly (remember the multiplier effect mentioned earlier). The person opening a spread betting account should learn about how to manage and limit the risk of large loses.

Spread betting is not like investing. It is not suited to a buy and hold strategy in the hope that asset prices will eventually increase. A spread bet can be kept open over a long term but the costs would be prohibitive. Spread betting on derivative markets with contracts expiring up to a year hence is a good way to spread bet on long term movement in prices.

When spread betting you never actually own or gain rights in the underlying asset. So you can’t receive an income (dividend) or vote for change.

What can I trade?

A big benefit of spread betting is that you never actually own the underlying asset. That means you have access to a wide range of markets which you’d never normally be able to access using a normal stock broker.
You can spread bet on a range of:
Equities (shares). Lots of shares including UK, US, European, and Asian companies listed on various stock exchanges around the world.
You can trade index markets or a sub sector. Trading a sub sector is a great way to trade emerging trends and ‘hot’ sectors.

Some spread betting companies will allow you to spread bet smaller companies.

Currencies and forex. Many currency pairs are available to trade. Trading commodity markets has become popular recently, think precious metals, crude oil, soybeans, corn, cattle, coffee and more.

Futures and options markets. Providing access to trading products otherwise not available to retail investors. These can be more complicated depending on your level of knowledge.
A range of calls and puts on various assets.
Trading interest rates through government bond markets or just trading interest rates set by the central bank of various countries.

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